Asset allocations adopted in the midst of a 40-year run of low inflation and sinking bond yields may be in need of a rework in the new higher inflation normal.
After the Federal Reserve launched one of the most aggressive interest rate boosting cycles in decades amid soaring inflation, investors are having to come to terms with the new economic environment, which some say could be heading toward stagflation.
That shift is also impacting their asset allocations, industry insiders said.
"I think our asset allocation is wrong," said Sung Won Sohn, a board member of the $21.5 billion Los Angeles City Employees' Retirement System, at its June 13 meeting. LACERS officials plan to embark on an asset allocation study early next year.
LACERS' asset allocation, adopted by the board three years ago, falls short because it was based on expected continued low inflation and a low interest rate, said Mr. Sohn, who is also a professor of finance and economics at Loyola Marymount University, Los Angeles.
"The world does change," he said. "I felt inflation would be very high" when the board was in the midst of the last asset review three years ago. "I wish I was wrong."
Pension funds and other asset owners are having very different conversations. This year, investors and their consultants are concluding they need to make sure their return expectations and their asset class choices are in line with new economic realities.
So far this year, the $309.3 billion California State Teachers' Retirement System, West Sacramento; $180.4 billion Florida Retirement System, Tallahassee; $87.9 billion Ohio Public Employees' Retirement System, Columbus; $43.1 billion New Mexico State Investment Council, Santa Fe; and $10.7 billion Chicago Public School Teachers' Pension & Retirement Fund have adopted new asset allocations or are on the road to doing so.
"In some ways higher inflation and higher (federal) funds rates did change our long-term asset return assumptions for each of our asset classes, especially for those that are inflation-rate sensitive," said Alison Adams, Portland-based managing principal and a research consultant on the capital markets research team at Meketa Investment Group.
In 2019, when Treasury bonds yielded 2.5%, institutional investors had to decide how risky a portfolio they had to have to get to a 6.5% to 7.5% assumed rate of return, Ms. Adams said.
"Now with government bonds providing healthy yields, it has changed that assumption," she said.
Unlike just a few years ago, investors are considering whether to incorporate more inflation-sensitive assets into their portfolios, Ms. Adams said.
"In 2019, you couldn't get some people to buy TIPS (Treasury inflation-protected securities) to save your life. Now many want TIPS and inflation-sensitive fixed income," Ms. Adams said.